Key considerations for landlords and tenants when negotiating leases
Commercial property partner, Helen Lucas, and consultant, Michael Whitaker, recently led a great discussion as part of our GC Know how programme. It focussed on key commercial property lease terms that are commonly contested during leasehold negotiations. Here, we note the key highlights from this session, focusing on alterations, repairs, break clauses, service charges, rent deposits, and the new minimum energy efficiency standards.
Alterations and reinstatements
Leases will generally contain provisions covering the tenant’s right to make alterations to the leased property, as well as corresponding obligations to reinstate the property at the end of a commercial lease. Helen and her team see such terms hotly negotiated, depending on a tenant’s intended use of the property.
Specification for proposed works
Tenants should aim to provide detailed specifications for any proposed works when the parties are negotiating the heads of terms. A specification should cover, for example, any proposals to raise ceilings, remove pillars, replace flooring, install lighting or bike racks, and so on. The specifications should also clarify the location of any proposed works – including whether the proposed alterations are internal and/or external alterations – as well as whether any of the alterations could be structural.
Helen notes that during this process, tenants must consider whether the proposed alterations involve areas of land or parts of property that fall under the remit of the lease. For example, if the tenant is only leasing the internal space within a building or other structure, it may not have the right to attach a fixture (for example, an EV charging point) to the exterior of the building.
Obtaining landlord consent in such cases can be tricky, plus there may be additional consent requirements to keep in mind, for example consents from adjoining land or property owners, permission from holders of third party rights relating to the property, planning or building regulation consent, and so on (all of which can result in additional costs and delays).
On a similar note, if a tenant is subleasing from a landlord that is in turn letting from a superior landlord, the parties should account for the time it might take to secure any required additional consents from that superior landlord.
This is all very important, as making alterations without the correct consents in place can constitute a breach of the lease and have a broad range of implications, from needing to undo those alterations and reinstate the property (at the tenant’s expense), to forfeiting the lease entirely.
The parties should also agree in advance the extent to which the tenant must reinstate the property once the lease ends, including whether the tenant intends to remove any equipment and fittings. Unless otherwise agreed, landlords have a fair amount of discretion to decide what tenants should leave or remove, so tenants should negotiate this point if they have specific intentions. With this in mind, tenants should be very clear on the scope of their reinstatement obligations, given the potential costs involved in reinstating a space or forfeiting equipment and fixtures that they have purchased and installed.
Repairs and dilapidations
Commercial property leases will also set out the extent to which tenants are responsible for repairing properties. The potential liability in this context will depend on the extent of the “demise”, i.e. the scope of what is actually covered by the lease.
A tenant should clarify in advance whether the lease covers both the internal areas and the structure and external façade, whether they would have responsibility for any issues with structural walls, foundations, roofs and windows, damp and mould, and so on. For these reasons, the definition of “property” in the lease is key.
If the tenant agrees to take on some responsibility for the building’s structure and foundations, Helen would recommend arranging a building survey in advance, then using this to evidence pre-existing issues (e.g. subsidence, damp etc.) and negotiate corresponding exclusions of responsibility for any such issues. If the issues discovered are particularly bad, tenants could even try to negotiate an obligation on the landlord to rectify the issues in advance or claim through an existing insurance policy (persuading a landlord to carry out repairs can be difficult in practice once the lease commences!).
Helen and Michael both discussed repair clauses and noted that tenants should also be aware that if the lease mandates that the tenant must keep the property in “full repair”, this essentially means the property must be put into as new condition during the term of the lease and left in such condition at the end of the lease, even if the property was in a lesser condition at the time the tenant moved in. This should always be negotiated, as tenants can otherwise become liable for the full refurbishment of the property. To that end, Michael sees a lot of disputes in practice regarding breaches of repair provisions, as tenants often overlook these provisions during the negotiation stage.
Tenants should also consider carrying out mechanical and electrical engineering surveys, as liability for any mechanical or electrical faults will usually transfer to the tenant once the lease commences, and these can be costly to rectify.
Break clauses can also prove contentious during commercial property lease negotiations. There are a broad range of options available to the parties when negotiating these, depending on the parties’ bargaining power. Helen notes that as a general rule, the more frequent or earlier the break clause for the tenant, the higher the rent the tenant has to pay. Or in other words, where a tenant is willing to commit to a longer period without an option to break, the landlord is often more flexible in terms of rent.
When considering their options, the tenant should think about whether they might need larger (or smaller) office space in the not-too-distant future, and – if they are investing in fit out works – the minimum period of occupation needed to justify the fit out costs.
When agreeing break clauses, the parties should consider when the break clause can be invoked, whether the right is mutual or tenant-only, how much notice should be given, and whether certain conditions should be attached (e.g. should the break clause only be conditional on payment of basic rent up until the break date, and the tenant giving up occupation).
Note that strict wording in a lease could mean that even a very minor or accidental breach of these conditions could invalidate a break clause. Also, beware of the phrase “vacant possession”, as theoretically, leaving a single chair or table in the building could constitute a breach of this provision, which could in turn invalidate the break clause.
Finally, if the lease is a sublease, the tenant would want to check whether the superior lease includes break clauses that if exercised would result in the tenant needing to vacate the premises.
Service charges are also often hotly contested during lease negotiations, and should be considered as early as possible. A higher than expected service charge could render a lease unaffordable, plus disputes often arise in relation to landlords either not carrying out the expected services, or charging more than the tenant expected.
Tenants should seek absolute clarity on how a service charge is calculated, which services they will be expected to pay towards, and (where applicable) whether contributions are proportionate compared to charges paid by tenants letting other areas of the same building.
Where possible, we recommend that tenants negotiate a cap on the service charge, as well as limits on the extent to which it can be increased (e.g. only in line with a fixed percentage annually, or by reference to the consumer price index).
Moreover, tenants should try to ensure that landlord obligations are noted precisely and cover repairs relating to any communal areas (e.g. lifts, the roof, stairways, structure etc.). To that end, a landlord’s obligations and commitments should not be caveated with loose wording (for example, tenants might want to avoid landlords only committing to using their “reasonable endeavours” to meet certain obligations).
Since 2016, landlords have been prohibited from granting new commercial leases of buildings with an Energy Performance Certificate rating of less than E. From 1st April 2023, this will apply to pre-existing lettings, such that it will be a breach of the regulations to continue to let a building with a rating of less than E, and the minimum rating is set to change to C or above by 2027, and B or above by 2030.
Responsibility for ensuring buildings meet this standard was intended to rest with landlords. However, this is not made clear in many leases, and it has consequently become a key negotiating point. In short, tenants want to ensure that their lease makes it absolutely clear that the landlord is responsible for ensuring the building meets this minimum requirement and that the tenant won’t incur costs in respect of works carried out to achieve the necessary rating (e.g. via the service charge, or as part of the tenant’s repair obligations).
Finally, despite their perceived simplicity, rent deposits can also cause a number of issues, most of which can be avoided through discussions at the heads of terms stage. Clarity is key.
For example, if a rent deposit is stated to be “3 months’ rent”, tenants should seek clarity in advance over whether there is VAT payable on top, whether the deposit needs to be topped up if the monthly rent increases further down the line, who pays the banking charges attributable to holding the rent deposit, the timing of and triggers for the return of the deposit, when the landlord can make deductions (and whether the tenant must then top up the deposit), and whether notice is required of such deductions in advance.
Partner Helen Lucas spent several years as a real estate lawyer at leading international law firm Allen & Overy LLP, before joining property and private client specialists Boodle Hatfield LLP. In 2015, she then joined Ignition Law, where she made partner and now heads up the firm’s experienced real estate team. Her practice includes all aspects of commercial real estate including leases, licences, property sales and purchases, development, real estate finance, property aspects of corporate transactions and advisory work.
Her client base is wide ranging from entrepreneurs and start-ups who have never occupied a commercial property before through to experienced property developers and investors requiring advice on structuring complex property deals.
Property Consultant Michael Whitaker has many years of experience in property dispute resolution working in private practice at Pinsent Masons, Charles Russell Speechlys and Eversheds Sutherland. Michael’s extensive experience stems from acting for a wide range of clients and undertaking both commercial and residential property law matters. He has supported institutional landlords with the management of their property portfolios, advised commercial tenants and corporate occupiers and assisted private landowners and tenants across a variety of sectors.
Michael focusses on providing practical and commercial solutions to his clients, to help them navigate and mitigate disputes as well as to anticipate and avoid them at the outset. He also has experience in advising on various technical property law matters from Easements and Nuisance to Telecoms and Rights of Light.